Business context and reporting period
Charles River Laboratories International, Inc. filed this unaudited Form 10-Q for the quarter ended September 27, 2014. The company is a global contract research organization serving pharmaceutical and biotechnology companies, government agencies, hospitals, and academic institutions. Its reportable segments are Research Models and Services (RMS), Discovery and Safety Assessment (DSA), and Manufacturing Support. Comparative segment results were recast to reflect the revised structure.
Financial performance and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $327.6 million | $292.1 million | $968.1 million | $876.3 million |
| Operating income | $46.2 million | $40.8 million | $136.9 million | $126.8 million |
| Operating margin | 14.1% | 14.0% | 14.1% | 14.5% |
| Net income attributable to common shareholders | $32.0 million | $30.9 million | $99.5 million | $83.7 million |
| Diluted EPS | $0.68 | $0.64 | $2.09 | $1.72 |
Revenue rose 12.2% in Q3 and 10.5% for the nine-month period. Service revenue was the larger growth contributor; reported revenue included foreign-exchange benefits of $1.2 million in Q3 and $6.1 million year to date. Gross margin, calculated from reported revenue and product and service costs, was approximately 36.1% in Q3 versus 34.2%, and 36.4% year to date versus 35.0%.
For the nine months, operating cash flow was $152.3 million, compared with $146.6 million. Investing used $217.2 million, principally for acquisitions; financing provided $44.3 million. Cash and cash equivalents were $130.7 million at September 27, 2014, down from $155.9 million at year-end. Total debt was approximately $769.6 million, versus $663.0 million at year-end; the company also reported $17.1 million of capital lease obligations. It had $145.3 million of cash and time deposits, most held by non-U.S. subsidiaries. The company was compliant with its credit-facility financial covenants.
Material changes versus prior periods
- Q3 DSA revenue increased $28.3 million, including $23.3 million from the Early Discovery acquisition; Manufacturing revenue rose $7.4 million. RMS revenue was essentially flat. For the nine months, DSA revenue increased $66.7 million, including $46.8 million from Early Discovery, while Manufacturing grew $24.4 million.
- Consolidated operating income rose 13.2% in Q3 and 8.0% year to date. Q3 margin edged up, but the nine-month margin declined 0.4 percentage points, reflecting higher corporate costs and other factors. Segment margin developments differed: RMS and Manufacturing improved year to date, while DSA’s margin benefited from higher Safety Assessment sales.
- SG&A increased 17.5% in Q3 and 18.0% year to date, including higher compensation, stock-based compensation, acquisition evaluation and integration costs, and other expenses. Intangible amortization also rose following the Early Discovery acquisition.
- Year-to-date interest expense fell to $9.2 million from $18.1 million, primarily because the 2013 retirement of senior convertible debentures reduced the effective interest rate. Q3 other income fell substantially year over year, partly due to lower limited-partnership investment gains.
Outlook, commentary, risks and unusual items
The filing does not provide specific numerical revenue or earnings guidance. Management describes demand, outsourcing trends, client spending, cost actions, acquisitions, foreign exchange, and liquidity as factors affecting future results; it cautions that actual results may differ materially from forward-looking statements.
- On April 1, 2014, the company acquired Early Discovery for a preliminary purchase price of $191.3 million, funded with cash and revolving-credit borrowings. The acquired business contributed $23.3 million of Q3 revenue and reported a $0.4 million operating loss for the quarter. VivoPath was also acquired in June for a preliminary $2.3 million, including contingent consideration.
- After quarter-end, on October 29, the company acquired ChanTest for $52.0 million in cash, with up to $2.0 million additional contingent consideration.
- The company recorded a $1.5 million reserve for identified excess billings on certain government contracts and said additional losses were reasonably possible, but it could not estimate a range beyond the reserve. A supplier arbitration resulted in a $1.6 million payment in September 2014.
- Limited-partnership investments are described as higher risk and volatile. Year-to-date other income included $7.4 million in investment gains and a $2.1 million non-cash gain related to assets at the Frederick, Maryland facility.
- The company identified interest-rate and foreign-exchange exposure. A hypothetical 100-basis-point rate increase was estimated to raise annual pretax interest expense by approximately $9.4 million. No forward currency contracts were open at quarter-end.
- Other matters include ongoing tax audits and uncertain tax positions, contingent acquisition payments, and lease commitments. Management reported no material change to the risk factors in its 2013 Form 10-K and stated disclosure controls were effective at a reasonable-assurance level.
Important facts for investors to verify
- How much reported growth reflects acquired revenue versus organic growth, particularly in DSA, and whether Early Discovery can improve profitability.
- Whether operating-margin pressure from SG&A, acquisition integration, and amortization persists, and whether efficiency initiatives deliver the expected benefits.
- Debt levels, variable-rate exposure, covenant compliance, and the effect of acquisition funding and share repurchases on liquidity.
- The eventual resolution and any additional costs related to the government-contract billing matter, tax audits, and other contingencies.
- The performance and valuation risk of limited-partnership investments, and the economics of the ChanTest acquisition and contingent consideration.